Departure from Covered Interest Parity (CIP), known as the cross currency basis, is not just a staple of crises: it can build up slowly and persist. Some bases exacerbated in 2008 and have not gone away since then. To understand this new normality, we turn the CIP logic on its head. We look at the Foreign Exchange (FX) swap market as the very market where scarce funding capacities are exchanged; the basis becomes an equilibrium outcome that compensates one of the parties for the temporary loss in the possession of one the currencies. Ultimately, the counterparty's funding pressure in that currency is what determines the willingness to pay for such endogenous possession value.

In our model of FX swap markets, banks compete for funding in two currencies. Banks face secured funding constraints, governing how securities can be pledged and short-sold. Banks' equity is tied to leverage ratio constraints, which end up bounding all their positions. However, the former, not the latter, is what drives the basis; this explains why bases also arise with no crisis in sight. A basis occurs when secured funding becomes more binding in one currency than in the other; leverage constraints can only have an accessory effect through this channel. Equivalently, the basis depends on how different across currencies are the spreads between actual (bank specific) unsecured borrowing rates and the secured rates. To illustrate, we look at central banks' cross currency actions targeting international funding pressures, in particular FX swaps lines and collateral policies.